You’ve probably heard about life insurance. But you may wonder if you need a life insurance policy—or if you can afford it—especially if you’re young and healthy. The short answer is: If someone in your life depends on your paycheck, a policy could prevent financial struggle should anything happen to you. But there are other factors to consider, too.
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Here’s what you need to know about life insurance.
What is life insurance?
At its simplest, life insurance is a financial safety net. A life insurance policy most commonly pays out a one-time, tax-free lump sum to loved ones after the person it insures passes away.
How does life insurance work?
In exchange for you paying a monthly fee called a premium, an insurer agrees to provide what’s called a “death benefit” payment to any loved ones named beneficiaries in your policy should you pass away while the policy is active.
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While that’s the bare bones dynamics, life insurance isn’t quite as simple as that. Life insurance comes in a couple of different flavors that determine exactly how, when and if a payout occurs, and many insurers will require you undergo a medical exam before providing coverage.
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That’s because life insurance as an industry depends on more premiums coming in than death benefits being paid out. Your eligibility and premium rates therefore are generally determined by your current health (and therefore the likelihood you will die while a policy is active).
Why do insurers take on your risk?
The insurance company is making a calculated bet that only a small portion of its policyholders will file a major claim at any given time. It’s betting that it will collect more in premiums overall than it will end up paying out for insurance claims.
Types of life insurance?
There are two primary types of life insurance: term and permanent (including whole).
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Term policies provide coverage for a set amount of years, like a 20-year period, meaning beneficiaries will only receive a payout if the insured person dies within that time frame. Term policies, like most other forms of insurance, are designed to provide peace of mind that if something does happen to those being insured, their loved ones will be financially covered. They’re more a parachute than an investment you hope will pay off.
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Permanent life policies, on the other hand, cover a policyholder’s entire life, assuming that person maintains premium payments. This means a payout will happen at some point.
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The most common type of permanent life insurance is whole life, a policy type that lasts the insured party’s entire life and, unlike term life insurance, accumulates cash value as you pay your premiums. This means whole life insurance can function as a kind of savings account and may even provide periodic payouts while you’re alive. While that might sound like a great pro in favor of whole life insurance, it comes at a cost.
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Because they provide coverage for the rest of your life and guarantee some kind of eventual payout, whole life policies can get pricey—up to six to 10 times more expensive than their term counterparts.
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Its expiration date makes term-life life insurance much more affordable for most people, and while it has an end date, you can always sign up for another term-life policy if you still need coverage after your previous policy ends. (It could be more expensive, though, if your health has declined.) You can also build the kind of automated savings that whole life insurance provides by regularly saving and investing while holding a term life policy.
How much life insurance do I need?
For those who need life insurance, most insurance companies recommend you get coverage for around 10 times your annual income. Your individual circumstances may vary, though, based on how much your loved ones depend on your income and the amount of debt you have, among other factors.
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Keep in mind that calculating your life insurance needs isn’t a one-time-only event. The amount of life insurance you need will probably change over the course of your life.
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Older people with grown children and a paid-off home, for example, might have enough money in savings and investments to cover any expenses related to their passing, making them less likely to need the kind of protection life insurance can provide, though they may still want to provide additional funds to loved ones through insurance coverage. Conversely, young people who in the past haven’t needed the security life insurance provides may find they want it as their families and financial obligations grow.
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Because of the varied nature of everyone’s finances, you may want to check with a financial professional to help you determine how much life insurance coverage you may need.
How can I get life insurance?
Most leading insurers provide both kinds of life insurance policies.
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This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.
